One high-yield stock I’d buy alongside 7.3% yielder SSE

G A Chester sees great value in SSE plc (LON:SSE) and an out-of-favour smaller company.

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At a little under 1,300p, the SSE (LSE: SSE) share price is 17% below its 52-week high of over 1,550p. Sentiment has been weak due to concerns about political risk and tougher regulatory demands.

However, this FTSE 100 utility has a history of adapting well to external factors. So much so that it’s built a long record of delivering value to shareholders through annual dividend increases. Indeed, its dividend record is unrivalled by any of its blue-chip peers across the whole utilities sector. As such, I believe the current share price represents an excellent buying opportunity.

Good compensation for uncertainty

In a trading update in January, SSE said it expects to deliver earnings per share (EPS) in the range of 116p-120p for its financial year to 31 March (results scheduled for release on 25 May). It also said it expects to report “an annual increase in the full-year dividend that at least keeps pace with RPI inflation.” The consensus among City analysts is for a 3.4% increase to 94.4p. At the current share price, the price-to-earnings (P/E) ratio, based on the mid-point of management’s EPS guidance, is 10.9 and the dividend yield, based on the consensus forecast, is 7.3%.

SSE expects to demerge its GB household energy supply and services business by the last quarter of 2018, or the first quarter of 2019. While the board has said it remains “committed to remunerating shareholders’ investment through the payment of dividends,” it has also said it will set out its future dividend policy in its demerger circular, which is expected to be published in June. So there’s some uncertainty here. But in my view, it’s more than compensated for by the historically cheap P/E and huge yield.

Resilient performance

Epwin (LSE: EPWN) is a leading manufacturer of low maintenance building products, supplying mainly the Repair, Maintenance and Improvement (RMI) market, but also new build and social housing. I like the long-term growth drivers in the RMI market, but conditions are challenging at present. Input costs have risen due to the weakness of sterling and Brexit uncertainty has subdued activity. Furthermore, Epwin’s two largest customers went into administration last year.

Despite the challenges, the company today reported what it called “a resilient performance” in 2017. Adjusted EPS came in at 13.47p, 10% lower than 2016, and the company highlighted “continued strong cash generation.” In the half-year results in September, management said cash generation gave it confidence in “our ability to offer an attractive dividend to shareholders.” 

Today, it increased the full-year payout by 1.4% to 6.69p, giving a yield of 8.6% at a current share price of 78p, down 1.9% on the day.

Generous valuation

However, the board has announced a new dividend policy for future years, namely, “a progressive dividend that is approximately twice covered by adjusted after tax profits.” This would imply a 5.3p dividend (6.8% yield) for 2018, based on a consensus EPS forecast of 10.6p (P/E of 7.4).

Epwin’s primary market remains challenging, but a cost reduction programme and a robust balance sheet to support ongoing investment in products, acquisitions and organic growth suggest to me that the prospective P/E and yield are far too generous. As such, I rate the stock a ‘buy’.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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